Low Probability of a September Fed Rate Hike?

The markets continue to assign low probability to a September Fed rate hike, as the latest US economic data show little inflationary pressures.   But, this expectation is not a slam dunk.  The real economy is growing above trend, and some Fed officials appear to be intent on sticking to a path of gradually raising the funds rate as well as beginning to slowly pare back the Fed's balance sheet.   Even NY Fed President Dudley expressed this view in an interview a couple of weeks ago.   Officials will have a window to make their case publicly in the next two weeks -- before the start of the blackout period ahead of the FOMC meeting.  Absent a concerted effort by officials to change market expectations about a September hike, the macroeconomic background will likely continue to support stocks and keep Treasuries little changed over the next few weeks.

With wage and price inflation remaining low and the Unemployment Rate little changed, a case for steady policy certainly can be made.  To be sure, all the evidence is not yet in, as the last important data before the September 19-20 FOMC Meeting will be the August CPI on September 14.  Another low print for the latter cannot be ruled out, however. 

Although newswires pounced on the slowdown in August Private Payrolls, after a downward revision to July, as a sign of labor market weakening, the two-month average shows a near-trend pace of net job creation (184k versus 185k Q2 average).   In other words, the August slowdown could be just payback for the strong July.  The underlying job pace actually may be improving, given the downshift in Initial Claims in the past 3 weeks (to 234k on average from 243k in July).  Note that BLS is scheduled to release its estimate of the next Benchmark Revision to Payrolls on Tuesday, September 6.  This could be important if the estimated revision (in either direction) is large (0.3% or higher).

A number of Fed officials appear intent on sticking to a path of gradually raising the funds rate as well as on beginning to slowly pare back the Fed's balance sheet.   There has been a subtle shift in their downplaying the currently low reading on inflation.  Besides attributing some of the low prints to one-off price drops, they now emphasize their expectation that inflation will rise to 2.0% in the medium term.   In other words, current inflation may not matter in their decision making.  In addition, the Fed may want to reach its funds rate target for the year while Yellen is still in charge.  Conceivably, she could be a lame duck chair in December if Trump announces a successor to the Fed chairmanship.

The damage from Hurricane Harvey could hold back a September Fed rate hike if only for political appearance sake.  But, aside from appearances, the hurricane should not stop the Fed from hiking.  Although some macroeconomic data will likely show a negative impact on the economy from the hurricane, including Initial Claims and Payrolls, the drag should be temporary.   Rebuilding and catch-up in delayed purchases and hiring will turn the disaster into a positive for growth.